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Today’s topic: how to do employee bonuses (and how not to do them)
Let’s do it!
Types of bonuses
First, let’s run down the options for monetary rewards:
Milestone incentives — when an employee hits a specific performance goal
Annual incentives — can be tied to the business’s overall performance, their personal achievements, or a combination of both
Referral bonuses — tends to improve the quality of new hires, as long as you build in a minimum retention period (3+ months) before the bonus is paid out
Sales commissions (a.k.a. variable pay) — common for sales roles, only works when the employee is directly responsible for closing deals
Hiring bonuses — makes you more attractive to top talent in a competitive hiring market
Profit sharing plans — which I’ve written about here
All of these can be great tools when used properly. But there are some easy pitfalls to watch out for. So…
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How to get bonuses wrong
❌ Bonus on things outside the employees’ control. That’s not a bonus plan – it’s a lottery.
❌ Make it too complex. Bad bonus plans are difficult to understand both for employees and their managers. As Einstein said, “Make it as simple as possible but no simpler.”
❌ Cap the upside. Bad managers create bonus plans that cap. Employees should be able to keep winning if the company wins more.
❌ Assume it won’t be gamed. Munger said, “Show me the incentives, and I’ll show you the outcome.” (Or something like that.) Before rolling out your bonus plan, ask yourself, “How would I cheat this?”
❌ Don’t tie bonuses to results. Great bonus plans align the company's fundamental mission with the individual's performance. Does the company do better? Employees make more.
❌ Give bonuses to the wrong people. I’ve seen truckers get annualized bonuses on par with senior executives. The lower you go in an org, the more the bonus should be tied to individual day-to-day.
❌ Don’t evolve the plan. Bad bonus plans are stuck in the past decade. It’s normal and natural for bonus plans to change regularly to match the company's current situation.
❌ Rushing it. Leaders sometimes give up on bonus plans before they have enough data. Remember, sales and financials are lagging indicators of performance. Give the plan a chance with enough time.
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Don’t ask me how many of these I’ve done personally.
Thanks for reading.
Michael
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